Contributed by: MatthewD, FreeTaxUSA Agent, Tax Pro
With gig businesses growing rapidly, many business owners are using a room or space in their home as a home office or workspace. If you qualify, you may be able to claim a home office deduction for the business use of your home.
Two methods are available:
- Simplified method
- Actual expense method
The IRS simplified method is a flat-rate tax calculation which allows eligible self-employed individuals to deduct $5 per square foot for a qualified workspace. This method avoids detailed receipt tracking and home depreciation calculations. It also limits the deduction to $1,500 for up to 300 square feet of office space.
The IRS actual expense method allows you to deduct the actual costs of operating your home office. You generally deduct direct expenses (those that only benefit the business space) in full and allocate a share of indirect expenses (like mortgage interest, utilities, rent, and insurance) between business and personal use. You’ll need to keep supporting documentation of the costs, but this method may result in a larger deduction than the simplified method.
What are direct and indirect expenses?
Direct expenses are home office expenses used exclusively for business. Examples include installing dedicated office wiring or lighting, repairs limited to the office, and services such as a dedicated internet connection or fax line.
Indirect expenses are costs related to the entire house, such as mortgage interest, real estate taxes, household utilities, and homeowner insurance.
Generally, reporting a home office expense is fairly simple. One complexity arises when you move to a new home and continue operating your business. This means you need to determine the business-use percentage (or ratio) for each home office, so you calculate the expense correctly and avoid claiming too much.
When preparing your tax return, remember the following rules for home office expenses.
- Eligibility: You must be self-employed, a freelancer, or an independent contractor to claim a deduction.
- Business use: The office space must be used regularly and exclusively for business.
- Limit: A home office deduction can’t exceed the net income generated by your business.
- Multiple home offices: When using more than one home office for the same business, the IRS requires using the same method (actual expense or simplified) for that business the entire year.
Example 1: Simplified method
A small business using the simplified method for two offices after a move.
Jane has a small business selling used clothing she finds at estate sales, yard sales, and thrift stores. She uses a spare room in her rented apartment to organize inventory, package orders for shipping, and handle her bookkeeping. On July 1, she moved to a new rental apartment.
Jane wants to keep her taxes as simple as possible, so she chooses the simplified method to claim a deduction for the business use of her home.
In Jane’s first apartment (800 square feet), her office space measured 12 x 10 feet (120 square feet). Her second apartment (1,200 square feet) has a larger room measuring 12 x 16 feet (192 square feet).
She’ll need to enter information for both home offices in the tax software and use the simplified method. The simplified method assumes she used the space for the whole year. Because she lived in one apartment for half the year and another apartment for the other half, she must allocate the deduction between the two home offices. Jane allocates 50% of each home office for the portion of the year it was used, 60 square feet for the first apartment and 96 square feet for the second apartment.
The following is an example of how to enter this type of situation in FreeTaxUSA: Follow menu path: Income > Business/Rental Income > Business Income (Schedule C). Select Edit next to the business and then click on Start (or Add) next to Home office Expenses.
On the Tell us about your home office page, Jane will select Yes to use the Simplified method.
Next, Jane will enter the allocation of 60 square feet for the first home office.
After entering information for the first home office, she’ll add a second home office and enter the allocated square footage for it.
The total allocated space of 156 square feet x $5 (per square foot) = $780, Jane’s total home office deduction. Jane's Schedule C, line 30 will look like this:
Example 2: Actual expense method
A small business using the actual expense method for two home offices after moving to a new house.
John is retired and started an online business selling used products he buys from yard sales, estate sales, rummage sales, etc. He uses a spare bedroom in his house as an office space with a desk, tables, and shelving for running his business. In August, John sold his home and bought a home near a family member in a neighboring town.
John elected to use actual expenses for his home office deduction. In his first home (1,800 square feet), he used a 10 x 12 foot office (120 square feet) for 8 months of the year (8/12 or 67%). After moving, he used an 11 x 12 foot office (132 square feet) in his second home (1,580 square feet) which he used for the remainder of the tax year or 4 months (4/12 or 33%). In order to correctly calculate the home office deduction, he must only report the expenses for the months each office is used.
In the software, John will enter each home office separately, along with the expenses attributable to each space for the period he used it for business.
He will also enter the cost of each home, along with the sale date for the first home.
When two or more offices are entered, the software will ask for the ratio or percentage of earnings and expenses for each home office. This is where the ratio above is used (assuming the earnings and expenses are basically the same).
Conclusion
A qualifying home office may allow you to deduct certain expenses related to the business use of your home. These deductions can reduce your taxable business income, thus lowering your self-employment and income taxes. Keep in mind home office expenses are limited to your net business income. Moving to a new home during the year can create complications. If you have questions, visit the FreeTaxUSA Community or contact Customer Support for additional help.